According to the press and even the Case of the Case Schiller Index, 2011 will bring a housing recovery of sorts. This may very well be true. Recovery means that something is getting better, not necessarily that gets well. If the residential housing market recovers at all, it will be from almost dying on the operating table to resting in the intensive care unit.

Let’s illustrate this with a few housing stats. It is easy to lose sight of the big picture if everyone gets excited about housing starts ticking up or home prices increasing in any given month. A chart helps put these small changes in perspective.

Case Schiller 20 City Index

Let’s begin by looking at the Case/Schiller home price index. Prices have not changed materially since declining about 30% from the peak by early 2009. Even if prices start trending up, it will take years of them to return to their bubble heights. (Here is a Pivot Point Advisors article warning about the housing bubble in July of 2006.)

Housing Starts

% Loans in Foreclosure

Next let us look at Housing Starts, a measure of new home construction. This index is a measure of builder optimism. Builders will construct more houses if they expect to be able to sell them profitable. The chart clearly indicates that while housing starts bounce up and down, builders are fundamentally pessimistic about their ability to sell houses. Note that this chart goes back to 1980. It includes the housing bust of the ’80s, which did not trigger nearly the same level of builder pessimism.

Lower prices mean lower profits for builders. This explains part of why housing starts are so low. However, competition from the swelling number of foreclosures is surely a stronger disincentive. The chart at right shows the percentage of real estate loans in foreclosure over the last 30 years. It speaks for itself. All of these properties will eventually hit the market as banks and mortgage companies unload them at a discount.

So are the builders overly pessimistic? I don’t think so. According the the Wall Street Journal, banks and mortgage companies currently sit on enough homes to satisfy demand for 107 months (nearly nine years!). This counts homes near foreclosure and homes that have been foreclosed. Even if there are no more foreclosures after today and demand recovers, this enormous backlog will hold prices down and depress building activity for years. As we pointed out in a previous post, this will also keep unemployment high, because the building industry is one of the few to employ undereducated laborers.